European investors must prepare for a year of geopolitical instability

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Roula Khalaf, editor-in-chief of the FT, selects her favorite stories in this weekly newsletter.

The writer is the editor of the Wealth of Nations newsletter

Investors approached 2025 with a mindset deep sadness on the prospects for the European economy. Almost all fund managers started the year underweight European stocks and few expected them to outperform. It turned out to be a mixed call. The Eurostoxx 600 rose 15.5 percent, barely underperforming the S&P 500, up 17.5 percent. But for euro-based investors, a decline in the dollar meant they would barely break even on an investment mirroring the blue-chip U.S. index.

As we approach 2026, the mood is quite different. The latest from Bank of America Survey of European fund managers shows that a net 78 percent of investors expect stronger European growth over the next year, the highest since mid-2021. At the same time, 92 percent expect gains for European stocks – a record level. Liquidity levels among European fund managers fell to a 12-year low, at 2.8 percent.

This optimism is mainly fueled by expectations of stronger global growth, helped by Germany’s fiscal stimulus measures. But this was the surprise of 2025 and one would think that it was widely taken into account by now. In theory, next year’s best chance of upside lies in a quick end to the war between Ukraine and Russia. But as Washington pushes the two sides to reach a peace deal, investors would do well to temper their expectations for a meaningful economic dividend.

The most obvious channel would be a fall in energy prices. The new US National Security Strategy asserts that the return of “strategic stability” with Russia is essential to the recovery of the European economy. This implies that a peace deal would lead to a rapid lifting of sanctions and the resumption of European imports of Russian oil and gas.

Of course, this is difficult to reconcile with the Trump administration’s previous demands that the Europeans accelerate the elimination of Russian hydrocarbon imports and purchase $250 billion a year of U.S. liquefied natural gas. On the other hand, it is less difficult to reconcile reports that Donald Trump’s donors are in negotiations to buy stakes in Russian gas projects in the Arctic and in the Nord Stream 2 gas pipeline.

It is a reasonable bet that Europeans will not rush to become dependent on Russian gas again and that imports will increase slowly. The European economy would benefit from an improvement in consumer confidence, as well as the resumption of certain bilateral trade thanks to reconstruction spending. But that would be offset by the hit to domestic consumption as refugees return home.

A peace deal is therefore unlikely to change Europe’s economic trajectory in the short term. Indeed, Goldman Sachs estimates that even a comprehensive peace deal would add just 0.5 percentage points to euro zone growth. A more fragile ceasefire would bring a gain of 0.2 points.

What would really move the needle on long-term growth would be significant progress in implementing the reforms recommended in 2024 by former Italian prime ministers Mario Draghi and Enrico Letta. Analysis The European Council for Policy Innovation found that so far only 11 percent of Draghi’s recommendations have been implemented. But will the end of the war in Ukraine open political space for faster action?

The danger is that political conditions are about to become more difficult, not least because EU efforts to deepen the single market could face active opposition from the United States. According to the NSS, the United States opposes “incursions by the most intrusive transnational organizations that undermine its sovereignty and supports the reform of these institutions so that they…serve American interests.”

EU efforts to redirect savings toward domestic investments risk conflicting with U.S. demands that Europeans invest more in America. European plans to deepen the single defense market and boost domestic arms production have already sparked complaints of discrimination against U.S. suppliers. The NSS condemned plans to boost energy independence through renewable energy development, calling them “subsidizing” China.

Meanwhile, the NSS considers support for far-right “patriotic” parties that oppose European integration a U.S. national security priority. The administration has already demonstrated with Argentine President Javier Milei how far it will go to support aligned foreign actors.

The divisions seen in recent weeks between European governments over the proposed reparations loan to Ukraine could be a precursor of what is to come. A peace deal in Ukraine will force Europeans to face new challenges, including whether and when to admit Ukraine as a member of the EU.

Threatened by Russia and intimidated by America, Europeans face an extraordinarily narrow path – especially in the face of intensifying competition from China. Investors should prepare for the prospect of a peace deal in Ukraine which, far from ushering in renewed prosperity, leads to even greater political instability.